6 June 2010
Hotel Lawyer with the mood of the financial capital and the NYU Hotel Investment Conference.
This has been a very interesting week. JMBM’s Global Hospitality Group® has a lot of work in New York and throughout the East Coast, so I have had more than a dozen business meetings this past week with industry leaders at major banks, Wall Street firms and institutional owners of hotel properties. Then the 32nd NYU Hotel Conference kicked off tonight with the Grand Reception at the Marriott Marquis in Times Square.
Boy, has the tide turned! Here is my take on the situation.
Everyone is getting busy and deals are getting done!
We noticed the sea change at Meet the Money® just about a month ago, where industry leaders reported that debt financing is available again and lenders are bidding against one another in rather competitive fashion.
Of course, financing is available only for existing product with a positive cash flow, and is generally being underwritten at a yield of 10-12% (i.e., cash flow available for debt service) with rates approaching 9 or 10%. Borrowers seeking to finance new construction need not apply, nor anyone seeking refinancing on the basis of former value or former cash flow.
But there is financing available for those who can qualify. Deutsche Bank, for instance, is actively lending now and in my meetings this past week, it is clear that they have a number of increasingly aggressive competitors.
You have to be in New York to really get the pulse. In office after office, almost everyone was busy doing deals. In one office, there were 3 closings this week (purchase of distressed debt). At a major bank’s office, a sale of a troubled hotel that was in escrow fell out of bed, and everyone was scrambling to take the asset back immediately. At another major bank, there were several different troubled hotel loan/portfolio issues under focused “resolution.” No fewer than 3 major lenders were looking to get back into hotel lending. Almost every investment bank had several billion of new capital in a fund to buy hotels, buy hotel debt, recapitalize borrowers, or make new senior or mezz loans (one lender willing to leverage the capital stack up to 75% LTV). Capital is actively seeking experienced operating partners.
Don’t misunderstand the message. People were not 2007-euphoric. Those days are behind us. But deals are happening again. The log jam has NOT broken. There is no torrent of deal opportunities. But things are starting to move in a meaningful way. This is a serious change of the tide.
Some very mixed signals – some incredible prices, cap rates, and deals
Clearly we have some daunting “hurdles” to jump over on the way to a sustainable recovery. For example, how about material improvement in the U.S. employment situation? How do we get out of this mess if we don’t make real progress on putting more than 7 million Americans back to work who lost their jobs in the past two years? And now some very smart people, like Sam Zell at the recent ULI conference, are starting to say that we have to add an additional factor to real estate investment for the “political risk” in the U.S. – like costs of social entitlements, health care, labor costs, inflation, interest rate increases (from a growing host of factors like spiraling federal deficits, impact of increased taxes on disposable incomes and attractiveness of capital investment, and so on).
But then we have some properties transacting at rather remarkable prices. For instance in the wake of the Marriott Los Angeles and the Watergate in Washington, DC, the latest buzz at the conference is the sale of the Sir Francis Drake hotel at what is effectively a 2% cap rate at more than $90 million by reported buyer Pebblebrook. Or other recent transactions by Asian investors who seem to have a very low investment return hurdle with long-term horizons.
Are transactions like these prudent and sustainable, or are they the product of a drought in available investment grade product for a long time, and pent up demand from all the usual players, but also supplemented by foreign buyers with different investment horizons and parameters. Will these deals look rich in 6 months or cheap? Mike Cahill of HREC reports that on properties in Dearborn, Michigan and Knoxville, Tennessee, they are seeing wealthy local (non-hotel) players step up and pay big prices for hotels because they like the idea of being owners of a hotel and don’t see how values can go any lower.
Hotel industry fundamentals
In a preview to the Lodging Industry Investment Council (or LIIC), which I am privileged to co-chair with Mike Cahill of HREC and Sean Hennessey of the New York-based Lodging Investment Advisors, Mark Lomanno of Smith Travel Research gave us the highlights of his update to be presented tomorrow.
My interpretation of Mark’s data: The good news is that if we are not at the bottom, we are probably pretty close. Occupancy is definitely improving, but we have made no progress whatsoever on improving ADR.
How can that be? Normally, Mark says it takes 5-6% of increased occupancy to restore pricing power to the hotels. Some cities (like New York) are approaching that, but seem to have no pricing power. Other markets are not even close yet.
Where do we go from here?
Forecasts by STR for 2010 say that supply will continue to grow at 2-2.5%. Demand will be up almost 5.7%, and occupancy will be up 3.6% (greater demand but more supply).
ADR will be slightly negative (i.e. -0.6%). However, with the increased occupancy, this will give a slightly better RevPAR growth of 3% for 2010.
For 2011? Supply up 0.6%, demand up 3.1% (harder comps), ADR growth at 4% and RevPAR growth at 6.5%.
When do we get back to 2007 RevPAR? Mark Lomanno says, “We are years away from getting back to where we were.” Some optimists hope that we get back to 2007 RevPAR in 2013 or 2014. Others think it is a much longer horizon. And on an inflation-adjusted basis, it will be much, much longer.
What are the best markets? New York is the first market to start recovery (but even NY has not been able to increase ADR). Mark likes Miami particularly and thinks that Atlanta and San Francisco will outperform. He also likes places with steady demand generators like college towns where parents will continue to need hotels to stay in to visit their kids in college.
What could upset the apple cart?
The tentative direction of recovery appears very fragile and vulnerable. The recovery for the hotel industry so far is entirely based on demand with no increase in rate. So any event that affects demand could take things off track – a terrorist event (what if the times square bomb had worked), a pandemic (a new flu epidemic or pandemic), erosion of consumer confidence, the “second shoe” in financial markets from prime mortgages or bank failures or . . .
A lot could go wrong. We hope it does not. And it appears that things are on the right track for now. But this is clearly a very fragile recovery at this point with a lot of pent-up capital and a lot of hopes that may or may not be fulfilled.
This is Jim Butler, author of www.HotelLawBlog.com and hotel lawyer, signing off. We’ve done more than $87 billion of hotel transactions and have developed innovative solutions to unlock value from troubled hotel transactions. Who’s your hotel lawyer?
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